Should you apply for Obama’s student-loan relief?

Millions of cash-strapped Americans may soon be able to reduce their monthly student loan payments thanks to a proposal President Obama will make Monday. But just because you can cut payments, doesn’t mean you should.

President Obama announced Monday that he will expand a federal program designed to reduce student loan payments. The program — dubbed “Pay As You Earn” — will give as many as five million more Americans with federal student loan debt the ability to cap their monthly student loan payments at 10% of their income and to have their remaining debt forgiven after either 10 years (for government and some non-profit workers) or 20 years (for other workers). “This can be very important to folks who aren’t earning what they’d hoped to earn based on how much they invested in their education, says Mike Sullivan, chief education officer for Take Charge America, a national nonprofit financial education agency offering student loan counseling. “It could represent a 50% or more reduction in the amount due each month.”

Obama: Student-debt burden too big to shoulder

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President Obama talks about the burden of college graduates making ends meet before signing a presidential memorandum on reducing student loan debt. Photo: AP.

The current program is only available to Americans who began borrowing after October 2007 and kept borrowing after October 2011; the new order will allow students who borrowed money before October 2007 and those who have not borrowed since October 2011 to participate. The new program will begin in December 2015.

The move could offer relief to many former students. Outstanding student loan debt climbed by $114 billion in 2013, hitting $1.08 trillion at the end of the year, according to the Federal Reserve Bank of New York. Student loans now have a higher delinquency rate than that of credit cards, mortgages or auto loans, as more than one in 10 student loan payments are more than three months late. Furthermore, the demand for repayment plans that take into account one’s income is already high.

The number of borrowers who are currently using an income-based repayment program or Pay As You Earn program to repay their student loan debts has climbed 24%, to 1.63 million just from January through March, according to the Education Department. (The income-based repayment program lets those with certain financial hardships reduce their payments to a maximum of 15% of their discretionary income.) Currently, nearly one-tenth of all outstanding federal student loan debt is being repaid using an income-based repayment program or Pay As Your Earn program.

Many debtors who may be newly eligible for “Pay As You Earn” are wondering whether they should try it — or another, similar income-related repayment plan like income-based repayment plans, income-contingent repayment plans; and income-sensitive repayment plans. First, it’s important to note that these plans are for people who have both low incomes (income levels vary depending on size of loan debt) and are struggling to make monthly payments on their student loans, says Sullivan. “Look at what percent of your disposable income is going towards your student loans — if it’s significantly over 10%, it’s worth exploring [other repayment] options; if it’s over 20%, it’s definitely worth it,” he says.

On the other hand, “if your total student loan debt at graduation is less than your annual starting salary, you can repay your student loans in ten years or less,” says Mark Kantrowitz, the senior vice president and publisher of Edvisors Network Inc. — and in most cases, if you can afford to repay your students loans quickly, you should. (Otherwise, you’ll likely pay significantly more — sometimes tens of thousands of dollars — in interest over the life of the loan; the Pay As You Earn program, for example, extends your payments out to 20 years, which means you’d likely pay significantly more than you would have during a 10-year period.)

Obama: Higher education most important investment

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In a White House appearance to sign a presidential memorandum reducing student loan debt, President Obama stressed the the importance of higher education in an improving economy. Photo: AP.

Most students who can afford to pay off their loans via the 10-year standard repayment option likely won’t qualify for the Pay As You Earn plan anyway. Indeed, for many people, the “Pay As You Earn” plan — even if it does require you to pay more money over the life of the loan — makes the most sense if it’s one of the only ways they could make their payments. For such borrowers, experts say, the program should be taken advantage of so that their credit score isn’t harmed due to delinquencies.

All of the payment-relief options are detailed in this U.S. Department of Education chart. (Borrowers can also ask their loan servicers to help them go through these options.) Some plans make more sense for certain borrowers than others, and not everyone will qualify for all of these options (for example, they typically don’t apply to private student loans and consolidated loans), says Sullivan.

Experts say many public service or government workers may want to try “Pay as You Earn” even if they can afford their normal repayments. “Almost anyone who qualifies for the public service loan repayment after ten years will get a financial benefit,” says Kantrowitz — because whether you do standard repayment or an income-related payment (which has lower monthly costs), the loan term ends in 10 years (and with the Pay As You Earn plan the outstanding loan amount at the 10-year mark will simply be forgiven). Furthermore, for other types of workers, “if you are negatively amortized — meaning your monthly payment is less than the new interest so debt is growing — you could get a significant benefit at the end of twenty years [when the debt is forgiven],” says Kantrowitz.

There are some things that people who opt for “Pay As You Earn” must understand before they jump in. First, if your income later rises, you may have to pay significantly higher payments. “It’s wonderful relief in the short term, but don’t lull yourself — it’s not a guarantee of modest payments forever,” says Sullivan. Plus, the “Pay As You Earn” program requires you to submit documentation every year on your income and family size — or you risk having your payment reset — and you may have to pay taxes on the amount of the loan that is forgiven at the end of 20 years.

Bottom line: Every student loan repayment situation is unique, so use calculators — like those available from the U.S. Department of Education — to compare plans both in terms of monthly payments and lifetime cost.

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